MBA 8360 Ch 18-19

While the general concepts of investment value and market value are very similar, there is an important distinction between the two. All of the following statements regarding investment value are true EXCEPT: A. Investment value is based on the expectations of a typical, or average, investor. B. Investment value is a function of estimated cash flows from annual operations C. Investment value takes into consideration estimated proceeds from the sale of the property D. Investment value applies a discount rate to future cash flows.

A.) Investment value is based on the expectations of a typical, or average, investor.

Prior to determining the treatment of capital expenditures in the calculation of NOI, it is important to distinguish these costs from operating expenses. In contrast to operating expenses, capital expenditures: A. add to the market value of the property B. are deductible for tax purposes in the year in which they are paid. C. are necessary to keep the property operating and competitive in its local market. D. may include minor repairs that do not add to the property's useful life.

A.) add to the market value of the property

Given the following information regarding an income producing property, determine the NPV using levered cash flows in your analysis. Required equity investment: $270,000; Expected NOI for each of the next five years: $150,000; Debt Service for each of the next five years: $125,000; Expected Holding Period: 5 years; Required yield on levered cash flows: 15%; Expected Sale Price at end of Year 5: $2,000,000; Expected Cost of Sale: $125,000; Expected Mortgage Balance at time of sale: $1,500,000 A. $245.15 B. $270,245.15 C. $419,264.54 D. $1,435,029.64

A. $245.15

The use of financial leverage in purchasing an income-producing property can affect the amount of cash required at acquisition, the net cash flows from rental operations, the net cash flows from the eventual sale of the property, and the ultimate return on invested equity. Assuming the going-in IRR is greater than the effective borrowing cost, if an investor increases his leverage rate, say from 75% to 80%, we would expect which of the following to occur? A. Both NPV and going-in IRR increase B. NPV decreases, while going-in IRR increases C. NPV increases, while going-in IRR decreases D. Both NPV and going-in IRR decrease

A. Both NPV and going-in IRR increase

It is common for investors in real estate to use mortgage debt to help finance capital investment. The use of debt can have a profound impact on the expected cash flows for a particular property. Which of the following terms refers to cash flows that represent the property's income after subtracting any payments due to the lender? A. Levered cash flows B. Unlevered cash flows C. Discounted cash flows D. Compounded cash flows

A. Levered cash flows

Changes in the discount rate used to complete net present value analysis can have a significant impact on the estimated value of the investment and therefore affect the overall investment decision. As the required internal rate of return (IRR) increases, the net present value will: A. decline B. increase C. remain the same D. become zero

A. decline

Net present value (NPV) is interpreted using the following decision rule: The investor will purchase the property as long as the NPV is: A. greater than zero B. equal to zero C. less than zero D. equal to the opportunity cost of investment

A. greater than zero

Suppose the operating agreement of an LLC insists that all investors receive their pro rata share of all cash flows when a property is liquidated from the portfolio. If all 15 investors contributed an equal amount of equity in establishing the LLC, each investor should receive how much from the liquidation of a property valued at $3,500,000. A. $233,333 B. $350,000 C. $3,500,000 D. $52,500,000

A.) $233,333

Unlike the debt coverage ratio, the debt yield ratio (DYR) is not affected by the interest rate or amortization period of the loan; the DYR is simply a measure of how large the NOI is relative to the loan amount. Lenders who rely on this ratio are typically willing to accept a minimum DYR of A. 10% B. 20% C. 60% D. 80%

A.) 10%

Given the following information, calculate the capitalization rate for the following apartment complex. Number of apartments: 15; Market Rent (per month): $1,000; Vacancy and Collection Loss: 10% of potential gross income; Operating Expenses: 5% of effective gross income; Capital Expenditures: 10% of effective gross income; Acquisition Price: $1,710,000. A. 8.1% B. 9.0% C. 9.5% D. 10.5%

A.) 8.1%

In an analogy to the stock market, the net operating income of a property can be viewed as which of the following? A. Annual dividend expected to be produced by the property B. Annual return on the value of the property C. Market value of the property D. Price-earnings ratio of the property

A.) Annual dividend expected to be produced by the property

Profitability ratios, income multipliers, and financial risk ratios can be used to provide a quick assessment of a property's relative value. Which of the following ratios measures the overall income-producing ability of the property? A. Capitalization rate B. Equity dividend rate C. Debt coverage ratio D. Operating expense ratio

A.) Capitalization rate

Single year return measures and ratios can be categorized into three groups: profitability ratios, multipliers, and financial ratios. All of the following are considered financial ratios EXCEPT: A. Capitalization ratio B. Operating Expense ratio C. Loan-to-value ratio D. Debt yield ratio

A.) Capitalization rate

In discounted cash flow (DCF) analysis, the sale price of the property must be estimated at the end of the expected holding period. The most common method for determining the terminal value of the property is the: A. yield capitalization method B. direct capitalization method C. repeat-sales approach D. cost approach

B. direct capitalization method

The internal rate of return (IRR) on a proposed investment is the discount rate that makes the net present value of the investment: A. greater than zero B. equal to zero C. less than zero D. greater than the opportunity cost of not investing

B. equal to zero

Given the following information, calculate the cash down payment required to purchase the specific property. Purchase Price: $500,000, Loan Amount: 80% of purchase price, Up-front financing costs: 2.5% of loan amount. A. $90,000 B. $110,000 C. $136,250 D. $200,000

B.) $110,000

Given the following information, calculate the total amount of annual operating expenses for this income-producing property. Lawn care: $10,000, Property taxes: $24,000, Maintenance: $35,000, Janitorial: $25,000, Security: $32,000, Debt service: $145,000. A. $102,000 B. $126,000 C. $247,000 D. $271,000

B.) $126,000

Given the following information, calculate the after tax-cash flow for this property. Debt Service: $45,000; First-year NOI: $91,750; Tax liability: 25% of Before Tax Cash Flow. A. $23,812.50 B. $35,062.50 C. $68,812.50 D. $80,500.00

B.) $35,062.50

Given the following information, calculate the loan-to-value ratio for this property. Loan amount: $450,000, Interest rate: 7.5%, Acquisition price: $550,000 A. 0.18 B. 0.82 C. 0.99 D. 1.22

B.) 0.82

Given the following information, calculate the debt coverage ratio for this investment. Potential gross income: $120,000, Vacancy rate: 9%, Net operating income: $57,900, Operating expenses: $51,300, Acquisition Price: $520,000, Debt service: $40,000. A. 0.69 B. 1.45 C. 2.73 D. 8.29

B.) 1.45

Given the following information, calculate the debt yield ratio on the following commercial property. Estimated Net Operating Income in the first year: $250,000, Loan amount: $2,047,500, Purchase price: $2,730,000 A. 4.8% B. 12.2% C. 68.6 % D. 75.2 %

B.) 12.2%

Given the following information, calculate the going-in capitalization rate for the specific property. First-year NOI: $18,750, Acquisition price: $150,000, Equity Investment: 20%. A. 2.5% B. 12.5% C. 15.6% D. 62.5%

B.) 12.5%

In calculating the net operating income (NOI) of a property, the "above-line" treatment of capital expenditures implies: A. capital expenditures are excluded from the calculation of NOI. B. capital expenditures are included in the calculation of NOI. C. capital expenditures are set equal to NOI. D. capital expenditures are divided by NOI.

B.) capital expenditures are included in the calculation of NOI

The key to meaningful valuations in real estate is to use defensible cash flow estimates. All of the following statements are true in regards to generating accurate cash flow estimates EXCEPT: A. Investors should include only those sources of income and expenses that relate directly to the income producing ability of the property. B. Investors should only consider recent events, rather than long-term trends when evaluating revenue and expense items. C. Investors should obtain information about comparable properties whenever possible. D. Investors should take into consideration local zoning, land use, and environmental controls that may impact the future flow of funds.

B.) investors should only consider recent events, rather than long-term trends when evaluating revenue and expense items.

Given the following information, calculate the going-out cap rate. Estimated holding period: 5 years, NOI for year 1: $120,000, NOI for year 5: $150,000, NOI for year 6: $155,250, Expected sale price at end of year 5: $1,350,000. A. 8.9% B. 11.1% C. 11.5% D. 11.9%

C. 11.5%

Given the following information regarding an income producing property, determine the after tax internal rate of return (IRR). Expected Holding Period: 5 years; 1st year Expected BTCF: $30,656; 2nd year Expected BTCF: $33,329; 3rd year Expected BTCF: $36,082; 4th year Expected BTCF: $38,918; 5th year Expected BTCF: $41,839; 1st year Expected Tax Liability: $7,645; 2nd year Expected Tax Liability: $8,658; 3rd year Expected Tax Liability: $9,708; 4th year Expected Tax Liability: $10,798; 5th year Expected Tax Liability: $6,951; Estimated Before Tax Equity Reversion at end of year 5: $343,674; Expected Taxes Due on Sale at end of year 5: $32,032; Required equity investment: $241,163 A. 11.2% B. 13.3% C. 15.4% D. 20.3%

C. 15.4%

Given the following information regarding an income producing property, determine the internal rate of return (IRR) using levered cash flows. Expected Holding Period: 5 years; 1st year Expected NOI: $89,100; 2nd year Expected NOI: $91,773; 3rd year Expected NOI: $94,526; 4th year Expected NOI: $97,362; 5th year Expected NOI: $100,283; Debt Service in each of the next five years: $58,444; Current Market Value: $885,000; Required equity investment: $221,250; Net Sale Proceeds of Property at end of year 5: $974,700; Remaining Mortgage Balance at end of year 5: $631,026. A. 10.6% B. 12.2% C. 22.9% D. 33.4%

C. 22.9%

While net present value (NPV) and internal rate of return (IRR) analysis both may be used as investment decision criteria, there are some limitations to the IRR method that make its use as an investment criterion problematic in certain situations. All of the following are limitations of the IRR method EXCEPT: A. IRR calculations assume that cash flows are reinvested at the IRR, rather than at the actual rate that investors expected to earn on reinvested cash flows. B. With the IRR decision criterion multiple solutions may exist for investments where the sign of the cash flows changes more than once over the expected holding period. C. The IRR methodology cannot be used to make comparisons across different investment opportunities. D. The use of IRR as a decision criterion will not necessarily result in wealth maximization for the investor.

C. The IRR methodology cannot be used to make comparisons across different investment opportunities.

The loan-to-value ratio measures the percentage of the acquisition price (or current market value) encumbered by debt. To protect their invested capital in the event that property values do fall, commercial mortgage lenders generally require that the senior mortgage not exceed approximately what percentage of the acquisition costs? A. 60% B. 70% C. 80% D. 90%

C.) 80%

In determining a property's before-tax cash flow from operations (BTCF) and net operating income (NOI), it is important to understand how each accounts for the use of financial leverage in its calculation. Which of the following statements is true in regards to how these two measures account for the use of financial leverage? A. BTCF and NOI are both levered cash flows B. BTCF is an unlevered cash flow, while NOI is a levered cash flow C. BTCF is a levered cash flow, while NOI is an unlevered cash flow D. BTCF and NOI are both unlevered cash flows

C.) BTCF is a levered cash flow, while NOI is an unleveled cash flow.

The going-in capitalization rate can vary significantly by property quality. Which of the following classes of properties within a particular property type would be expected to have the highest cap rates? A. Class A properties B. Class B properties C. Class C properties D. Cap rates would be equal across all classes within the same property type

C.) Class C properties

Helpful in assessing the risk of lending to investors for particular projects, which of the following calculations measures the income-producing ability of the property to meet operating and financial obligations? A. Profitability ratios B. Income multipliers C. Financial risk ratios D. Income tax multipliers

C.) Financial risk ratios

In making single-asset real estate investment decisions, the first pass often involves calculating a series of returns, ratios, and multipliers. Which of the following is often cited as a limitation associated with this type of analysis? A. they are difficult to calculate B. they are complex to understand C. they fail to incorporate cash flows beyond the first year of the analysis D. they are rarely used by industry professionals

C.) they fail to incorporate cash flows beyond the first year of the analysis

Given the following information, calculate the before-tax equity reversion (BTER). NOI: $89,100, Annual Debt Service: $58,444, Net Sale Proceeds: $974,700, Remaining Mortgage Balance: $631,026. A. $30,656 B. $343,674 C. $572,582 D. $885,600

B. $343,674

Given the following information, calculate the NPV for this property. Initial cash outflow: $200,000, Discount rate: 15%, CF for year 1: $25,876, CF for year 2: $23,998, CF for year 3: $23,013, CF for year 4: $22,105, CF for year 5: $144,670. A. -$51,875 B. -$59,657 C. $140,343 D. $295,951

B. -$59,657

Given the following information regarding an income producing property, determine the unlevered internal rate of return (IRR). Expected Holding Period: 5 years; 1st year Expected NOI: $89,100; 2nd year Expected NOI: $91,773; 3rd year Expected NOI: $94,526; 4th year Expected NOI: $97,362; 5th year Expected NOI: $100,283; Debt Service in each of the next five years: $58,444; Current Market Value: $885,000; Required equity investment: $221,250; Net Sale Proceeds of Property at end of year 5: $974,700; Remaining Mortgage Balance at end of year 5: $631,026. A. 10.6% B. 12.2% C. 22.9% D. 33.4%

B. 12.2%

The use of financial leverage when investing in real estate is a double-edged sword. While increased leverage may allow the investor to "purchase" higher expected returns, the "price" of doing so is an increase in which of the following risks? A. Liquidity risk B. Default risk C. Interest rate risk D. Pipeline risk

B. Default risk

Just as it is important for an investor to consider the impact of financial leverage on her return, it is also necessary to account for the effect of income taxes. How would the presence of income taxes impact the levered going-in IRR? A. Income taxes increase the levered going-in-IRR B. Income taxes reduce the levered going-in-IRR C. Income taxes do not affect the going-in-IRR D. Income taxes cause the levered going-in-IRR to become invalid as a measure of return.

B. Income taxes reduce the levered going-in-IRR

Given the following information, calculate the estimated terminal value of the property at the end of its holding period. Going-out cap rate: 9%, Estimated holding period: 5 years, NOI for year 5: $100,500, NOI for year 6: $102,000. A. $1,113,333 B. $1,116,667 C. $1,133,333 D. $1,166,667

C. $1,133,333

Given the following information regarding an income producing property, determine the after tax net present value (NPV). Expected Holding Period: 5 years; 1st year Expected BTCF: $30,656; 2nd year Expected BTCF: $33,329; 3rd year Expected BTCF: $36,082; 4th year Expected BTCF: $38,918; 5th year Expected BTCF: $41,839; 1st year Expected Tax Liability: $7,645; 2nd year Expected Tax Liability: $8,658; 3rd year Expected Tax Liability: $9,708; 4th year Expected Tax Liability: $10,798; 5th year Expected Tax Liability: $6,951; Estimated Before Tax Equity Reversion at end of year 5: $343,674; Expected Taxes Due on Sale at end of year 5: $32,032; Required equity investment: $241,163; After Tax Opportunity Cost: 11.2% A. -$40,858 B. -$91,785 C. $40,858 D. $91,785

C. $40,858

In discounted cash flow analysis, the industry standard for pro forma cash flow projections of investment properties is typically: A. 3 years B. 5 years C. 10 years D. 15 years

C. 10 years

Given the following expected cash flow stream, determine the NPV of the proposed investment in an income producing property and determine whether or not the investment should be pursued. Investment Horizon: 5 years; Expected Yearly Cash Flow in each of the next five years: $127,628. Expected Sale Price at end of 5 years: $1,595,350; Opportunity Cost of Investment 6%; Current Market Price of Property: $1,750,000 A. NPV is -$20,246; Decision is to invest B. NPV is -$20,246; Decision is not to invest C. NPV is $249,967; Decision is to invest D. NPV is $249,967; Decision is to not invest

B. NPV is -$20,246; Decision is not to invest

An important piece of criteria for investors to consider when deciding between real estate investment opportunities and investing in stocks or bonds is the effect of income taxes on their return. For most investors, the effective tax rate on commercial real estate is: A. greater than the effective tax rate on a stock or bond investment B. equal to the effective tax rate on a stock or bond investment C. less than the effective tax rate on a stock or bond investment D. cannot be compared across asset classes.

C. less than the effective tax rate on a stock or bond investment

Many investors use mortgage debt to help finance capital investment for income-producing real estate. In doing so, the owner will receive income as long as the property produces enough income to cover all operating and capital expenditures, the mortgage payment, and all state and federal income taxes. Therefore, the owner's claim is commonly referred to as a: A. primary claim B. joint claim C. residual claim D. superior claim

C. residual claim

If the lender has agreed to offer you a loan with a loan-to-value ratio of 85%, what is the size of the loan if the purchase price of the home is $500,000? A. $75,000 B. $400,000 C. $425,000 D. $588,235

C.) $425,000

Suppose you plan to put a 20% down payment on a house and obtain a mortgage loan that is less than the size limit on conforming loans ($417,000) to finance the remainder of the purchase. Based on your understanding of the loan-to-value ratio, what is the maximum price that you could pay for a home with these restrictions in mind? A. $333,600 B. $500,400 C. $521,250 D. $2,085,000

C.) $521,250

Given the following information, calculate the effective gross income multiplier for the specific investment. Effective gross income: $49,500, First-year NOI: $18,750, Acquisition price: $520,000, Equity Investment: 20%. A. 0.036 B. 0.095 C. 10.5 D. 27.7

C.) 10.5

Given the following information, calculate the equity dividend rate for this investment. First-year NOI: $18,750, Before-tax cash flow: $11,440, Acquisition price: $520,000, Equity Investment: 20%. A. 2.2% B. 3.6% C. 11.0% D. 18.02%

C.) 11.0%

Given the following information, calculate the operating expense ratio for this property. Potential gross income: $120,000, Vacancy rate: 9%, Net operating income: $57,900, Operating expenses: $51,300. A. 34% B. 43% C. 47% D. 53%

C.) 47%

Given the following information, calculate the net income multiplier for this property. First-year NOI: $18,750, Acquisition price: $150,000, Equity Investment: 20%. A. 0.1 B. 1.6 C. 8.0 D. 12.5

C.) 8.0

A client has requested advice on a potential investment opportunity involving an income producing property. She would like you to determine the internal rate of return of the investment opportunity based on the following information. Expected Holding Period: 5 years; End of first year NOI estimate: $113,900; NOI estimates in subsequent years will grow by 5% per year; Price at which the property is expected to be sold at the end of year 5: $1,615,205.22; Current market price of the property: $1,475,667.71. A. -15.30% B. 8.60% C. 9.86% D. 10.00%

D. 10.00%

Suppose you purchased an income producing property for $95,000 five years ago. In Year 1, you were able to negotiate a lease that paid $10,000 per year at the end of each year. If you are able to sell the property at the end of year 5 for $100,000 (after receiving our final lease payment), what was the internal rate of return (IRR) on this investment? A. -18.18% B. 1.03% C. 9.57% D. 11.37%

D. 11.37%

Given the following information, calculate the appropriate after-tax discount rate. Tax rate on comparable risk investment: 35%, Investor's before-tax opportunity cost: 12%, Capitalization rate: 8%. A. 2.8% B. 4.2% C. 5.2% D. 7.8%

D. 7.8%

The measure of cash flow most relevant to investors in income-producing real estate is the after-tax cash flow (ATCF) from property operations. Therefore, it is important to know that the maximum federal income tax rate on individuals as of 2012 is: A. 25% B. 30% C. 33% D. 35%

D.) 35%

To overcome the potential shortcomings of single-year decision making metrics, many investors in real estate also perform multiyear discounted cash flow (DCF) valuation. DCF valuation differs from the single-year ratio analysis in all of the following ways EXCEPT: A. Only with DCF must the investor estimate an appropriate investment horizon accounting for how long she will hold the property. B. Only with DCF must the investor select the appropriate yield at which to discount all expected future cash flows. C. Only with DCF must the investor make explicit forecasts of the property's net operating income for each year in the expected holding period. D. Only with DCF must the investor use a defensible cash flow estimates that incorporates appropriate measures of income and expenses.

D.) Only with DCF must the investor use a defensible cash flow estimates that incorporates appropriate measures of income and expenses.